The likelihood of a US rate hike in June is falling fast, as is the US dollar.
Just one week ago, the implied probability of the Federal Reserve hiking US interest rates at next month’s meeting – a probability derived from prices in Fed funds futures contracts – stood near 85%. As of Monday, that probability had fallen to 74%, and at the end of yesterday’s session (Wednesday), it stood at roughly 62%. Another day like either of the last two and we might be looking at a coin flip scenario ahead of the meeting.
Rate expectations, and consequently US dollar exchange rates, have tumbled following political rumblings in the US in recent days which, as ever, are centred around Donald Trump.
The US Dollar Index (DXY) fell for its fourth consecutive day yesterday, closing at 97.39, down 0.8 points on the day and down 2.3% since Thursday of last week.
Reports on Tuesday suggested that President Trump had asked the now-fired FBI Director, James Comey, to stop an investigation into his former security adviser Mike Flynn. And these followed an earlier bombshell that the President had shared classified information with Russian officials during a meeting last week.
Whatever the facts are, Trump’s apparent conduct has worked to drive down expectations for tax reform and fiscal stimulus, both of which have been key Trump pledges and were expected to reflate the US economy, but which now might be difficult to implement.
In stark contrast to the dollar’s post-election honeymoon period in November and December of last year, in which the Dollar Index rose 7%, investors are now fleeing the American currency to account for what they see as a necessary political risk premium.
Even prior to this week’s fall, the Dollar Index had declined 4.5% since highs reached on January 3rd at 103.82 on the grounds that Donald Trump, for all his promises, had yet to “walk the walk” in terms of policy implementation or certainty of plans.
EUR/USD Threatens 1.12 and Yen Gains Across the Board
The dollar’s fall has pushed a resurgent EUR/USD to new six-month highs of 1.1172 in early trading on Thursday.
The Japanese yen has also benefitted from a flight to safety in the past 24-hours. The yen has gained across the board but gained most against emerging market currencies and, of the majors, against the Australian dollar and Canadian dollar. Exchange rates for USD/JPY, AUD/JPY and CAD/JPY have fallen to 110.80, 82.34 and 81.42 respectively.
Surprisingly however, the yen has failed to respond to this morning’s positive GDP data.
Japan’s Cabinet Office said this morning that the country’s economy grew by 0.5% in Q1 – better than the forecast for 0.4% – and that previously recorded Q4 growth has been revised up from 0.2% to 0.3%. Today’s data seals five consecutive quarters of Japanese growth, which is the first time in eleven years that has happened.
The yen is virtually unchanged following GDP, something which might be attributed to what United Overseas Bank have today described as a USD/JPY downtrend “running ahead of itself.” The bank also said that USD/JPY shorts entered at levels around 111 do not offer an attractive reward-to-risk ratio. In other words, we might say that the yen is suffering from too much love yesterday.
Trump Effect Spreads Far and Wide
Currencies have not been the only markets affected by Trump’s shenanigans.
The CBOE’s market volatility index, the VIX, exploded yesterday. The index, which is derived from 30-day implied volatilities from US equity options, had found a base in recent weeks between 10 and 11, to the disappointment of many as these levels are close to multi-decade lows. The index jumped to 15.6 yesterday, producing its largest one-day rise since September.
Gold and US Treasuries, which like the yen are considered safe haven assets, also posted big gains. Gold rallied almost $25 yesterday, ending at $1260.09, and yields on the 10-year US Treasury fell to 2.22% as Treasury prices rallied the most since July.
In equity markets, the Dow Jones Industrial Average plunged 370 points – its largest daily fall since September.
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